Choice 2. It is exactly what the government wanted all along. If the Israeli public thinks that Israel has suffered a great defeat, they will think that they simply cannot win any wars these days, and will have to accept a life under constant rocket fire, and will think that they must do anything that the Muslims want in order to survive (in essence becoming dhimmis in their own country).
Chaim, I told you that this was what the Israeli government was trying to do all along, and you didn't believe me. I told you Kadima did not want to defeat Hamas, but lose to them.